Fundamentals of Microeconomics Consumer Behavior

Puzzle Why the consumers are so different? Consumer preferences Budget constraints What amount and types of goods will be purchased? Origin of demand? how to decide demand? Given a certain budget how does a consumer decide which good\service to buy? Theories of consumer behavior

Law of Diminishing Marginal Utility (U-Function). = added satisfaction declines as a Consumer acquires additional units of a given product Wants in general may be insatiable. Particular Want may be satisfied. In a particular span of time over which the consumers’ tastes remain stable, the consumer can obtain as much of a good as he wants

Law of Diminishing Marginal Utility (U). The more of the product obtains the consumer, the less he wants still more of it. Want is a motive to be satisfied. How? By means of Utility. U- is a want satisfying power. Wants?

Characteristics of U Utility of a good is the pleasure or satisfaction on gets from consuming it. Utility Vs Usefulness (=functional) U is subjective U is difficult to quantify Total utility – total amount of satisfaction a person derives from consuming some specific quantity of a good

Marginal utility = is the extra satisfaction a consumer realizes from an additional unit of the product he consumes = the change in total U that results from the consumption of 1 more unit of a product

MU @ Demand MU=> the demand curve slopes downward Less satisfaction => additional unit would be bought only if the price falls How Consumers allocate their money incomes among many goods for purchase

Consumer choice @ Budget constraints ASSUME: Rational behavior – to maximize satisfaction with the money Clear-cut preferences, clear ideas of MU Budget constraints – at any time a consumer has a fixed amount of money Prices (for all goods which are scareced)

Preference Notation A ≻ B: A is preferred to B. A∼ B: A is indifferent to B. Basic assumptions for preferences Completeness -can rank any basket of goods.(always possible to decide preference or indifference) Transitivity - A≻B and B≻C implies A≻ C. This assumption seems obvious, but can have contradiction.

Example of contradiction of transitivity. Non-satiation -more is better. (Monotonicity). Convexity -given two indifferent bundles, always prefer the average to each of them..

Convexity of indifference curve. = the average point C is more preferred to A or B

Utility Maximization Rule (UMR) To maximize satisfaction the consumer should allocate the money income so that the last dollar spent on each product yields the same amount of marginal (extra) utility When the Consumer has the margins balanced using the UMR he achieves consumer equilibrium

consumer equilibrium

How to measure MU? Not directly but by ranking various combinations of goods in terms of preferences. The model of Consumer Behavior based upon such ordinal utility is Indifference Curve Analysis. Elements of Indifference Curve Analysis Budget Lines Indifference Curve

A Budget Line = is a curve (schedule) showing various combinations of 2 products a consumer can purchase with a specific money income

A Budget Line characteristics Income changes: the location of BL varies with money income. An increase of money shifts the curve to the right. Price changes: also shifts the budget line. A decline in prices of both products shifts the line …

Indifference Curves = show all the combinations of 2 products that yield the same total satisfaction of total U to a Consumer The Consumer subjective preferences are such that the total utility of each of the combinations is the same

Indifference Curves j k l m 12 6 4 3 2 4 6 8 j k l m I 2 4 6 8 10 12 Quantity of A Quantity of B j Combination Units of A Units of B j k l m 12 6 4 3 2 4 6 8 k l m I 7-19

Properties of indifference curves Downward sloping: if not, non-satiation violated. Cannot cross: if not, non-satiation and transitivity cannot be satisfied simultaneously. Shape: describes how willing one is to substitute one good for another.

Marginal rate of substitution (MRS) The slope of an indifference curve at each point measures the MRS of combination of 2 goods. The slope of MRS shows the rate at which the consumer who possesses the combination must substitute one good for another to remain equally satisfied: How many units of Y one is willing to give up in order to get one more unit of X.

Marginal rate of substitution (MRS). A consumer’s subjective willingness to substitute Х for Y will depend on the amount of X @ Y he begins with. People prefer a balanced basket of goods. MRS decreasing.

Cases MRS Perfect substitution. MRS is constant. Perfect complements. Indifference curves are shaped as right angles. Example (Perfect complements). Buying shoes. People need both the left one and the right one.

UM @ Demand Curve. Basic determinants of the Demand: preferences of tastes, money income, prices of other goods Income and Substitution Effects: Income effect is the impact that a change in the price of a product has on a consumer’s real income and on the quantity of the good demanded Substitution effect is the impact that a change in a product’s price has on its relative expensiveness and on the quantity demanded

Income and Substitution Effects: substitution effect income effect

The Role of Time in Demand. Consumption-rhythm-time Components of Consumption: Money price Time price The willingness to pay a premium for time-saving goods depends on the opportunity costs of the time of the consumer => differences in the consumptions patterns